EconoMeter: Do tax cuts lead to economic growth?

Trickle-down economics has been shown to work for taxpayers and businesses in extremely high tax brackets, say 50% plus, but every empirical study including those by the CBO have suggested very modest impacts on economic growth and negative effects for the budget deficit. Politicians have never been obligated to rely on facts or truth so they spout unfounded theories that do not apply to a global economy. Only transformational technologies or cheaper resources will really spur economic growth, although lower taxes on corporate America would be generally beneficial.

Generally, tax cuts lead to more economic activity, which is why they have been part of most stimulus programs, including those implemented by both Democrats and Republicans. The structure of cuts will determine their impact. Tax cuts focused on household spending will tend to have a more immediate effect, while cuts promoting saving and investment will have a longer term impact. The major constraint limiting the effectiveness of tax cuts involves the deficit. If investors regard government finances as tenuous, they will demand higher interest rates, which could choke off any positive impact intended by the tax reductions.

In general, tax cuts increase economic growth. If the economy is at less than full employment, there are idle resources that can be put to work when demand for goods and services rises. This will increase the pace of GDP/output growth. Demand increases because consumers have more take home pay, which they normally spend, while businesses may increase output and employment if each dollar of profit is taxed at a lower rate. Tax cuts have to be paid for, though, and if government spending is cut to keep the deficit from rising, the cuts in government spending will offset some or all of the stimulus from a tax cut.